A Fed Divided

The minutes to the July 30-31 Federal Open Market Committee (FOMC) Meeting reveal a committee even more divided than was on display when members voted to cut rates by a quarter percent on July 31. There were two participants at the meeting who were lobbying for a one-half percent cut in short-term rates, while several participants (more than the two regional presidents eligible to vote to dissent) wanted the Fed to hold its ground and stand pat on rates.

The reasons the Federal Reserve cited for the rate cuts were threefold:

1. The U.S. economy is decelerating.
2. The Fed needs to hedge against downside risks associated with weaker growth abroad.
3. Inflation remains dangerously low.

The word “risk” was mentioned 44 times (10 to the “downside), “trade” was mentioned 32 times and “uncertainty” was mentioned 14 times.

The divide on the Fed is not likely to dissipate much by the time of the next FOMC meeting in September. Data on the domestic economy has surprised to the upside, while trade tensions have escalated. The positive economic data will further entrench traditionalists who believe they must stay in their own lane and only react to domestic conditions, while widening the gap with progressives who realize that the Fed is traveling on a global highway. The Fed is the central bank to the world and affects what happens abroad, but those shifts also have a feedback loop that could wash up on our shores.

The July minutes underscore why Fed Chairman Jay Powell had such a hard time explaining the Fed’s decision to cut rates; the vote cleared by an even smaller majority than depicted in the statement; they had two extremes fighting against each other. Look for Powell to attempt to corral the cats with his speech in Jackson Hole on Friday. He will emphasize the reasons for a rate cut, which match those above. He will also have to explain what a “mid-cycle adjustment” in rates actually means, which could be a challenge given the divisions within the Fed.

Powell risks disappointing financial markets by only signaling a possibility instead of a strong probability of another rate cut in September. I think the Federal Reserve Board and a critical mass of the Fed regional presidents will support him with a September rate cut, but it is a closer call than it was prior to the release of these minutes.

The only silver lining for a Fed so divided is that it sends a strong message to financial markets about how independent it remains as an institution. The president’s bullying has had no impact on the views of regional Fed presidents, the Chair or the Governors. If it did, they would be singing in sync and pushing for much more aggressive cuts. They aren’t there yet.

Bottom Line
We still expect the Fed to cut rates two additional times this year. That is a heavier lift than previously estimated but prudent given the storm clouds forming abroad and the reality of tariffs at home. They are costly.

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